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Mezzanine equity combines loans from investors with equity, offering a way for small businesses to raise capital without collateral or a proven track record. Lenders receive high interest rates and may gain capital through equity if the business cannot repay the loan. Mezzanine capital can improve a business’s bottom line and attract other forms of financing.
Mezzanine equity is a type of financing plan for a business that combines loans from investors with equity offered to those same investors. The general idea behind this is that the business will pay the lender in equity if it cannot pay it back with equity. For a business, mezzanine capital is a way to get quick and substantial financing and improve its bottom line. Investors in this deal benefit if the business grows because they will receive their loan repayment with interest or have their shares grow in value.
Borrowing money is often a necessary process for small businesses that may initially lack the capital to compete with well-established market forces. Unfortunately, lending options for such start-ups are often limited, as they may lack the track record to attract significant capital from banks and are not large enough to go public on the open market. For these small businesses, mezzanine capital is a possible way to raise the money they need to grow.
The basic structure of the mezzanine capital arrangement is a simple loan from some investment entity to a business. Such loans are typically secured despite no collateral being offered and without the company having a proven track record of earnings to prove its long-term value to investors. Since that is the case, the interest rates offered to the lender upon repayment are significantly higher than what an established company could offer.
If the business is unable to repay the loan, then the lender is paid with equity in the business in the form of preferred stock, which essentially gives the lender a piece of ownership of the business. The mezzanine equity loan is typically subordinated to other business loans, meaning the business will only start repaying it after its principal debt, such as bank financing, is paid off. Given this, it is a distinct possibility that the lender will gain capital.
Another benefit of mezzanine capital is that the business can include it on its balance sheet, which makes the business look more attractive to investors and therefore opens up the possibility of other forms of financing. The business typically regains control over operating decisions, although lenders may have a say depending on how much equity in the business they get from the deal. This capital is attractive to investors, as they may have the opportunity to cash in on their shares if the business becomes a bigger player in the market at some point in the future.
Smart Asset.
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